When you purchase a new pair of jeans or splurge on an expensive dinner, you’re spending the money you have after using your paycheck to pay for necessities. But, it’s possible to have little to no money left after paying for your necessities if your student loan payments are high.
If you find it difficult to pay your student loans every month, you may want to consider an income-driven repayment (IDR) plan, which takes your discretionary income into consideration. Learn more about what discretionary income is, how to calculate it, and if an IDR plan is a viable option for you.
What Is Discretionary Income?
Discretionary income is the money you have after paying necessary expenditures throughout the month such as rent, utilities, transportation, food, and health-related expenses. In other words, it’s the leftover money you have after paying your obligatory bills. It may be the first expenditure you’ll try to reduce if you’re trying to save money.
To uncover what your discretionary income is, subtract your necessities from your take home pay (minus taxes). For example, if your monthly take home pay is $2,500, and your rent and utilities are $750, your car payments and insurance are $150, you spend $300 on groceries, and $30 on prescriptions on a monthly basis, your discretionary income is $1,270 ($2,500 – $1,230). That’s the money you have to spend on monthly “extras” and paying back loans.
What Is the Difference Between Disposable and Discretionary Income?
It’s easy to confuse disposable and discretionary income, but if you’re considering an IDR plan, it’s important to decipher the two.
Disposable income is the income that an individual or household has available after income tax — just subtract your income taxes from your income. For example, if you make $40,000 per year, but pay a 30% tax rate, your disposable income would be $28,000 ($40,000 – $12,000). This is the money you spend on necessities, paying back loans, saving, investing, or splurging.
However, discretionary income is the income that an individual or household has available after income tax and paying for necessities — just subtract your income taxes and necessities from your income. For example, to play off of the example above, if you have $28,000 left after income taxes ($2,333 per month), you subtract your rent and utilities, car payments and insurance, grocery bill, and prescription. Let’s say your necessities cost $1,230 on a monthly basis, then your discretionary income would be $1,103 ($2,333 – $1,230).
How Is Discretionary Income Connected to Student Loan Payments?
When it comes to your student loans, the federal government or your student loan provider will calculate your discretionary income a little differently to determine a repayment plan. The U.S. Department of Education considers your discretionary income to be the difference between your annual income and 150% of the poverty guidelines for your family size and state of residence. Use the charts below to determine what 150% of the poverty line is for your state of residence and household size.
If you reside in one of the 48 contiguous states or the District of Columbia, calculate your discretionary income using the following 150% of poverty guideline.
If you reside in Alaska, calculate your discretionary income using the following 150% of poverty guideline.
If you reside in Hawaii, calculate your discretionary income using the following 150% of poverty guideline.
How to Calculate Discretionary Income Using Poverty Guidelines?
Student loan providers use discretionary income to determine how much you should pay per month through an IDR plan. Using the poverty guidelines above, subtract 150% of the poverty guideline from your income. For example, if you make $40,000 per year, live in a contiguous state, and are the only one in your household, your discretionary income is $27,860 ($40,000 – $12,140). That means that your monthly discretionary income is $2,321 ($27,860 / 12).
But, don’t worry. Even if you have thousands in discretionary income, your student loan provider won’t make you use all of it towards student loans. You’ll typically pay 10% to 20% of your discretionary income towards your student loans through an IDR plan. For example, if your discretionary income is $2,321 per month, you’ll pay around $232 towards your student loans.
It’s important to remember that although an IDR plan can make student loan repayment more manageable, it also means that your repayment term could extend to nearly 25 years, and as a result paying more interest over time. With that in mind, you may want to use a loan repayment calculator to find out how much you need to increase payments to shorten the duration of the loan.
If you’re considering an IDR plan, you can typically complete the process in about 10 minutes without needing to calculate your discretionary income on your own — it will be done for you through the application process.